The story behind Alascom, GCI and AT&T's fight for the Last
Frontier's long-distance lines

"This process is virtually incomprehensible to the average
humanoid." That candid and mostly-serious concession comes from an
expert on Alaskan telecommunications -- Susan Knowles of the Alaska
Public Utilities Commission (APUC), which oversees long-distance
telephone service in Alaska. Just about everyone agrees that
long-distance service has become a complicated tangle of corporations,
regulations, history, consumer interests, special interests and
competition. Only on a daytime soap opera could you find something more
complicated or bizarre.

The major corporate players in the unfolding drama include Alascom
(an Anchorage-based, wholly-owned subsidiary of Vancouver, Wash.-based
Pacific Telecom Inc., which is 87 percent owned by utility conglomerate
PacifiCorp of Portland, Ore.); and GCI (an Anchorage-based corporation
now 30 percent owned by MCI). The latest entrant into the fray is global
telecommunications giant AT&T (based in New York). Of the three,
Alascom has the deepest Alaskan roots and probably stands to undergo the
most change as a result of the upcoming industry restructuring.

The Evolution of Confusion

The confusing mix of regulations and competing interests evident
today has much to do with how Alaskan telecommunications evolved. It was
government, not private industry, that in 1900 took the first serious
step to provide Alaska with a communications network. A 25-mile military
telegraph line from Nome to an outpost at Safety, Alaska, was part of an
ambitious plan by the Army Signal Corps to connect scattered military
outposts in the Alaska territory with the United States. The system
allowed public and commercial use as well as government business.

By 1905, thousands of miles of land lines, a submarine cable and a
rudimentary wireless radio link formed a moderately reliable network
known as the Washington-Alaska Military Cable and Telegraph System. In
1935, the growing system changed its name to Alaska Communications
System (ACS) -- a name and a government system that would last well into
the 1960s, when most of the traffic was commercial, not military.

By 1967 Congress decided the system, now handling 95 percent of
public and commercial traffic, should be sold to private enterprise. The
Air Force, operating the Alaskan system, evaluated bids from seven major
communications corporations. RCA was the winner with a bid of nearly
$28.5 million. The newly created RCA Alascom division took control in
1971 of most "long lines" facilities and became the only
company other than AT&T providing long-distance service in the
United States.

Bush Communication

As a condition of state certification, Alascom promised to provide
telephone service by 1973 to 142 villages not being served by the
existing network. The company quickly fell behind schedule and over
budget. The state pressured Alascom to revise plans for rural Alaska.
Alascom first refused, then later proposed alternatives unacceptable to
the state.

The Legislature in 1975 appropriated $5 million for construction of
small satellite earth stations in 120 villages with a permanent
population of 25 or more. First planned as an entirely state-run
operation, Alascom was later granted permission to be a partner in the
project with responsibility for installation, operation and maintenance
of state equipment. In addition to the 120 state-owned earth stations,
Alascom later began construction on 21 larger satellite earth stations
to replace the obsolete White Alice network of transmitters scattered
across Alaska.

Additions and improvements to the network continued. In 1973,
long-distance telephone service via satellite began between Alaska and
the Lower 48. Six years later, in 1979, RCA sold its Alascom division to
Pacific Power and Light (now PacifiCorp); the acquisition formed the
core of Pacific Corp's new Pacific Telecom division.

By the mid-1980s, Alascom had invested millions of dollars to create
a modern satellite and terrestrial microwave telecommunications network serving all major Alaska towns and more than 160 rural communities. The
network was viewed as a successful model for developing countries
worldwide faced with similar problems of serving a relatively small
population scattered across vast distances, often under inhospitable climatic conditions.

For its efforts, Alascom reaped the benefits of monopolistic service.
And while the rates it could charge were regulated by the APUC and the
Federal Communications Commission (FCC), the company had the opportunity
to receive a regulated rate of return on its investment. It also
received a large annual subsidy from AT&T, with whom it connected to
carry calls to and from the Lower 48 and the rest of the world.

Starting a Subsidy

In 1972, the FCC stated that with the inauguration of domestic
satellite service, Alaskan interstate rates should come down and
eventually match rates for like-distance calls between other Lower 48
states. The concept was known as "rate integration." To
accomplish this, Alascom took a decrease in its annual revenue and
argued that it could ill afford such a cut while operating where the
cost of doing business was considerably higher than in the Lower 48.

The FCC agreed, and in time, Alascom and AT&T agreed to a plan
(called the Joint Service Arrangement) under which AT&T would pay
Alascom's costs to provide interstate service. In exchange,
AT&T was entitled to Alascom's revenues generated by the
interstate service. In essence, a subsidy was created that covered the
difference between costs and revenues.

The concept of subsidizing a particular long-distance market was not
unique. AT&T routinely subsidized less profitable portions of their
own system with revenue from more lucrative markets. A complex formula
for determining Alascom's reimbursable costs was created, which
today allows Alascom to attribute 86 percent of its key investments in
major circuit equipment (microwave facilities, etc.) for interstate
service (costs that are subsidized). The remaining 14 percent is
allocated for providing intrastate service (which is not subsidized by
AT&T). It works out to an annual AT&T subsidy to Alascom of some
$80 million to $100 million per year to make up Alascom's
interstate expenses not covered by toll revenues.

David and Goliath

A lot has changed in the telecommunications industry since the 1970s
when the Alascom/AT&T interstate subsidy was formulated. Since 1982,
Alascom's competition has been primarily GCI, which began as a
company some people thought would prove to be little more than a
temporary thorn in Alascom's side. For some 10 years, Alaskans
watched David-and-Goliath phone companies battle for long-distance
telephone dollars.

The battles were fought in the courts, the Legislature, the
regulatory arena, in the press and in advertising. GCI, essentially free
to set its rates at will, attacked Alascom with interstate rates that
were typically just below Alascom's, which by regulation were, and
still are, tied directly to AT&T's Lower 48 rates. GCI seemed
to claim credit for forcing down Alascom's interstate rates by
introducing Alaskan competition. In fact, Alascom's interstate
rates were going down because AT&T, facing increased competition
from MCI and others, was cutting its rates. And as AT&T rates fell,
Alascom's had to fall.

On the intrastate side, where Alascom is not bound by AT&T rates
but still must secure APUC approval, GCI often continued to undercut Alascom rates by pennies or fractions of pennies per minute -- even as
Alascom cut its own rates. Alascom also countered with claims of
superior equipment, service, experience and a long history of investing
in Alaska.

By building its own facilities where it could and by leasing space on
Alascom's network elsewhere, the young GCI sometimes appeared
larger than it really was. Some services were initially bare-boned (GCI
had no long-distance operators for several years), and the advertising
budget was stretched thin. Today, GCI claims it has about 50 percent of
the long-distance customers in markets where it competes with Alascom.
Stressing customer service, GCI executive vice president and general
manager Wilson Hughes (a former Alascom engineer) explains, "People
want other services than just POTS -- plain old telephone service."

Alascom, feeling the sting of competition after years of regulated
monopoly, responded by paring its large work force, cutting costs,
increasing its advertising budget and improving its network and
services, including upgrading to digital technology.

Meanwhile, GCI's market success as well as Alascom's
continued profitability did not go unnoticed by AT&T. The corporate
giant was growing tired of shelling out nearly $100 million a year to
Alascom; at the same time AT&T faced new competition of its own in
the Lower 48. GCI and other Alascom critics also began to argue that the
long-standing AT&T/Alascom subsidy provided Alascom with an unfair
advantage. Particularly irksome to GCI was the fact that Lower 48
dollars provided by AT&T could be used by Alascom for advertising
and promotion.

New Competition and a New Joint Board

By as early as 1983, it was clear a new round of open competition
would again change the face of Alaska telecommunications. A
federal/state body, called the Alaska Joint Board, was created to
examine the interstate telecommunications market and reconcile the often
contradictory principles of open competition and regulated rate
integration or mandated averaging.

An impediment to open intrastate competition has been the concern
that competitors would choose to serve only the most profitable areas
and not the smallest rural communities -- a practice called
"skimming." This argument has long been central to
Alascom's position resisting GCI's entrance into the
intrastate market at the more attractive larger communities.

Alascom has insisted that the small rural communities, on their own,
are a money-losing operation. Under the concept of universal service,
rates are averaged for all market areas; the high profit areas support
the money losers -- a fact of telephone service in many places
including, for example, Nevada and Minnesota. The concept applies to
just two long-distance companies in the United States -- AT&T and
Alascom, both of whom are classified as carriers of last resort. In
other words, because these companies are the dominate carriers in their
regions, they must provide service if no one else does and do it for the
same averaged price. Other companies, like MCI, Sprint and GCI, can
choose to serve virtually at will (given some oversight by the
regulatory bodies).

Today, the Joint Board, Alascom, GCI and AT&T all agree that it
is time for a change toward a market-driven, open and competitive arena.
The Joint Board conceded that the AT&T/Alascom subsidy arrangement
gives "Alascom little reason to control costs." And in a
recent report it says, "There are few, if any, advocates for the
current market structure's preservation."

The first serious proposition was brought to the table last year by
Alascom and AT&T, who referred to their joint proposal as the
"master agreement." Included in the complicated proposal were
a number of sweeping changes in the way the market would be structured,
as well as a buyout of Alascom's interstate side by AT&T for
$330 million. The plan met with considerable opposition and died.

The Joint Board itself then fostered an alternative plan that is
today being reviewed and receiving comment. The complex plan would wean Alascom from the annual AT&T subsidy while still financially
compensating Alascom for its sizable investment over the years. In
theory, the plan would allow AT&T to enter the interstate market,
leave Alascom with less investment to carry on the intrastate side of
the books, and therefore help prevent any rise in intrastate rates to
the consumer in a competitive market. In effect, open, unsubsidized
competition would arrive while cushioning the blow to Alascom, which
would remain the regulated carrier of last resort.

Compromise Cuts Competition

The Joint Board proposes a number of changes, all of which would be
instituted and then phased out within the next 10 years. It calls for
Alascom's interstate cost allocation to shrink from 86 percent to
75 percent, thereby reducing AT&T's annual subsidy. To help
make up the difference to Alascom, the board has proposed the creation
of a nationwide fund into which phone companies all over the country
would pay. As the interstate allocation shrinks, Alascom's
allowable intrastate cost allocation for key investments would nearly
double, from 14 percent to 25 percent. To keep these intrastate costs
from causing a rate increase for Alaskans, the proposal would require
AT&T to "buy down" some of Alascom's investment,
i.e., reimburse Alascom. In the meantime, AT&T would also be obliged to contract with Alascom for the use of its equipment for at least three
years, providing another source of assured income for Alascom during a
transition period.

Alascom seems willing to accept this deal as the best compromise
package available. "We're prepared to go forward with exactly
what the Joint Board is saying, as long as there is a reasonable
transition period," says John Ayers, Alascom's executive vice
president and general manager.

Even GCI, faced with the entry of another formidable competitor,
feels that the Joint Board proposal represents the best compromise
available. "The solution to the Alaskan market structure is
AT&T entry into the market," agrees Dana Tindall, vice
president of GCI's legal and regulatory department. "It's
always been our position that (AT&T's entry) is what needs to
be done."

AT&T, however, thinks it has a better idea, which it recently
proposed as an alternative to the Joint Board proposal. By comparison,
their plan appears to be a remarkably simple and straight-forward
approach in an arena strewn with complex timetables and calculations.
AT&T proposes a complete and immediate elimination of the Alascom
subsidy; it would enter direct competition with Alascom and GCI for
interstate calling to and from the Lower 48 at comparable nationwide
rates; it would be prepared to construct much of its own $230 million
network, including a new state-of-the-art fiber optic cable linking the
Lower 48 and Alaska through Juneau and Anchorage; and it would provide
complete intrastate service across Alaska using either its own equipment
or through facilities leased from Alascom or GCI at rates equal to or
less than Alascom or GCI for at least five years, except to pass through
APUC-approved increases in intrastate access charges.

Critics are not convinced. They point to that last clause about
passing though increased access charges. What that means, critics say,
is that if Alascom is granted increased intrastate rates to earn its
current rate of return in a shrinking market, AT&T's and
presumably GCI's rates will go up too, especially since both would
be paying to use some of Alascom's rural network.

However, both GCI and AT&T contend they could make a respectable
return at current prices regardless of where they might serve, even in
the Bush, if given unrestricted access. They say that new, lower-cost
technology plus current competitive market forces would give them an
edge over Alascom, which must support an older, more expensive network.

Doug Wilcox, AT&T's Alaska business unit general manager,
also tries to reassure critics by responding to a claim from John Ayers
that Alascom's intrastate rates will rise under unbridled
competition. "I tell John Ayers every time I see him, 'I love
that story, John. I hope you do it because I'll get all of your
customers!'"

After years of debate over the form and future of Alaskan
telecommunication, change appears close at hand. The period of review
and comment is well along, with a decision expected from the Joint Board
by fall. Implementation is expected to begin on the first of the year.
That said, it should also be noted that given the stakes and the
complexity of the issue, any decision could be appealed, negotiated or
litigated for some time.

But there does appear to be consensus on at least one point.
Competition will likely cull the competition. Few people seem to think
the Alaska market can support three major players the likes of Alascom,
AT&T and an MCI-affiliated GCI.

And like Alascom's Ayers muses, "Anything is for sale at a
price."

COPYRIGHT 1993 Alaska Business Publishing Company, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.